Corning Is Not Monkeying Around

Corning stands to benefit from increased sales of its well-known Gorilla Glass, as PC makers, including Apple and Dell, ramp up their use of the glass for touchscreen computers, tablets, and mobile handsets. Even if we leave iPad and Mac sales out of the equation, Apple is already using the glass in its mobile handsets (aka iPhones), and its recent introduction of lower priced versions of the iPhone line will only add to Corning's sales.

Corning says that the primary characteristics of this glass are its hardness and high scratch resistance, which allows Corning to use thinner glass in its applications without increasing fragility. A side benefit is that the glass is recyclable.

As of October 2012, over 1 billion mobile devices had Gorilla Glass installed. This number continues to rise, as manufacturers like Samsung use the glass in flat panel television screens, as well as in some of their high-end mobile devices. Available data indicates that 80% of smartphones shipped globally in the second quarter of 2013 were Android devices -- Samsung devices using Google's Android platform as the operating system. Early in 2013, Samsung predicted that it would sell as many as 500 million mobile devices, including 350 million handsets. If correct, the company will account for around 40% of all smartphone sales this year, with an expected 800-900 million sales. In all fairness, it should be pointed out that only a percentage of these devices will use the Gorilla Glass -- but its increased use paints a brighter future for Corning.

Revenue

Metric

June 30, 2013

June 30, 2012

June 30, 2011

Revenue (millions)

$1,982.00

$1,908.00

$2,005.00

% Change (YOY)

4%

(5%)

Specialty Materials revenue (millions)

$301

$296

$283

% Change (YOY)

1.7%

4.6%

Source: Capital IQ.

Corning's year-over-year revenue growth comes in at a paltry 4%, but amounts to a 9% improvement from the previous year. Gorilla Glass and a newer, closely related product called Willow Glass are part of Corning's suite of products within its Specialty Materials Segment. This segment reported net sales of $301 million, or 1.7% better than the previous year same quarter. The company notes in its latest quarterly report that it has focused R&D efforts to advance new product attributes of the Gorilla Glass suite of products. Furthermore, it is also focusing on opportunities that will leverage existing materials, such as Willow Glass, for use in next-generation consumer electronics.

Net sales, however, don't tell the whole story: The Specialty Materials Segment's contribution to second quarter net income increased from 7.2% in 2012 to 11.6% this year.

Metric

June 30, 2013

June 30, 2012

June 30, 2011

Gross Margin

45%

42%

44%

Operating Margin

22%

17%

21%

Net Profit Margin

32%

25%

38%

Operating Cash Flow Margin TTM

36%

44%

Source: Capital IQ.

Corning has improved its margins during the year, and has lowered its sales, general & administrative (SG&A) costs from 15% to 13% of revenue YoY. The company spends about 10% of revenue on R&D.

Cash flow

Corning also exhibits healthy operating cash flow. Last quarter operating cash flow was $395 million, and net income was $638 million. Net income was bumped up by an odd $251 million gain from currency exchange during the quarter. Ideally, we'd like to see higher operating cash than net income -- but currency translations are temporary in nature. If we back out this one item, it results in respectable earnings quality for the quarter.

Over the last 8 quarters, Corning has used cash to reduce its share count by 110.7 million shares. This has greatly helped earnings per share (EPS), creating average gains of 17% over the last year and a YoY gain of 39%, reaching $0.43 per share last quarter.

Along with rising receivables and inventories, Days Sales Outstanding (DSO) has been creeping up quarterly to its current value of 60 days. While we like that Corning is paying its bills, higher receivables and DSO are a concern. Under most circumstances, a rising DSO indicates an attempt to pull revenue in the current quarter rather than in future quarters, and revenue is not growing as well as we'd like. While we have already said that demand for Gorilla Glass appears to be growing, we repeat that this glass is only one of many products that Corning sells.

At $1.24 billion, inventory has never been higher -- but the ratio of finished goods to raw materials is at a low point at 86%, and is significantly lower than last year's 142%. Days in inventory stands at 103 days, also higher than the year over year number of 83 days. The take away here is that Corning has added an abundant supply of raw materials to meet coming demand.

Valuation

Corning's valuation metrics deserve mention. The price-to-sales ratio has averaged 2.6x over the last 2 years, and price-to-cash flow from operations has averaged 6.1x. The company pays a healthy 2.7% dividend ($0.40 annually), and, at its current price of $15, it has a trailing 12 month P/E ratio of 11.6 and a forward P/E of 10.6, which is cheap relative to the broad market.

Street expectations

Consensus estimates for EPS for the coming quarter are $0.33 a share versus an estimate of $0.34 a year ago. Also, revenue for the 3rd quarter is estimated to be $2.1 billion, up 3% from $2.04 billion last year. Full year revenue is estimated to be $8.03 billion, up only 0.3% from last year. Given the 4% growth rate previously discussed, it should be relatively painless to meet the Street's consensus.

Foolish bottom line

Corning has a clear chance with its Gorilla Glass product to increase revenue and profitability in the coming years. Use of mobile handsets, flat panel televisions, and laptop computers will only continue to grow, and Corning appears to have cornered the market for these applications. As always, Foolish readers should base investment decisions on earnings quality. Given reasonable expectations and valuations, however, shares may offer a decent value.

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